Hedge Fund Option Usage and Skewness Risk Premium

Abstract

We study how hedge fund option usage can affect the skewness risk premium in the cross-section of individual stock options. We find that stocks with more of their hedge fund holders employing the long naked put strategy (long put option without the underlying stock) have more positive returns of their skewness assets comprised of options, whose payoff (price) resembles the realized (risk-neutral) skewness of the underlying stock return. We document evidence consistent with a price-pressure channel: Those stocks face larger demand on their out-of-the-money put options, which makes their risk-neutral skewness more negative and lowers the price of skewness asset; In the meanwhile, the long naked put positions of hedge funds cannot predict the realized skewness. The channel works through the idiosyncratic rather than systematic component of skewness. Other hedge fund option strategies cannot robustly predict skewness asset returns.

Keywords: Skewness risk premium, option, hedge fund

JEL Classification: G12, G14, G23